The Home Construction Depression and Its Aftermath
A key question going forward for the economy and GDP: When will we recover from the home construction depression and at what rate?
First, a bit of history to put the issue in perspective. Housing starts are a standard measure of home construction. The Census Bureau each month reports the total number of starts for single homes and units in multi-family dwellings. There has been a steady and very steep decline from the peak of housing starts during 2005, at 2.05 million units, down to 0.90 million units for 2008 and then further down to an annualized rate of 0.53 million units for the first six months of this year. This is the greatest percentage drop in housing starts since the Great Depression. A 74% drop in housing starts from its peak is drastic and can only fairly be described as a ?home construction depression,? although the media and public officials are reluctant to use that term. Looking beyond the housing bubble years of 2003 through 2006, the approximate annual rate for the past 20 years was 1.5 million units per year. Even using that figure for perspective, at present, the 2009 rate amounts to a decline of 67% from the norm.
The government has taken numerous steps to bolster the overall economy and the home construction industry in particular. The Federal Reserve has aggressively acted to lower overall interest rates and home mortgage rates. In August 2007, the Federal Funds rate stood at 5.25%; by December, 2008, the Federal Reserve had effectively lowered that rate to zero, where it stands today. In March, 2009, the Federal Reserve announced that it intended to purchase 1.25 trillion dollars of mortgage backed securities in the remaining nine months of the year. By mid-July, it had already purchased half that sum. For perspective, the 1.25 trillion figure exceeds the entire amount the Obama administration indicates it needs to fund its health reform proposal. The Fed?s efforts have contributed to the reduction in the 30 year fixed mortgage rate from 6.7% in July, 2007 to a low of 4.8% in April, 2009 ? a mortgage rate last seen in 1953.
The Congress has passed an $8,000 tax credit for first time buyers of new and resale homes. California enacted an additional $10,000 credit for first time buyers ? the funds for that program are now exhausted
Thus far, all of these efforts have led to limited improvements in the prospects for future home construction. Housing permits are the measure of future housing production. Overall, they are near flat year to date, although permits for single family homes have climbed from an annualized rate of 0.34 million in January to 0.43 million in June ? a gain of 26%. Sales of single family homes are up from 0.32 million in January to 0.38 million in July.
Looking forward, a critical question for housing construction and the overall economy is: What are the prospects for a return of housing starts to the normal range of 1.5 million units per year? How long will it take to reach that level?
Three factors are likely to determine when and if housing construction will return to normal levels: (a) The current excess of housing inventory built over prior years and the time needed to burn off that excess; (b) The level of household formation; and (c) Consumer confidence and the condition of the overall economy. .
New home inventory has been steadily declining for the past three years. On an unadjusted basis, the inventory of new single family homes stands at its lowest level since 1998 and is half its peak level in 2006. At the same time, there is currently 8.8 months of inventory given the current sales pace. This is in excess of the 5 to 6 month level that most economists deem acceptable as a basis for sustained growth, but represents a significant improvement from the 12.4 month level at which inventory stood in January.
In addition to new home inventory, resale homes resulting from foreclosures and the desire of investors/speculators to sell prior purchases will compete with new home sales and thereby hold down new home construction. Many foreclosures are of homes built over the past five years, which directly compete with nearby new construction.
One demographic unknown is the residential plans for retiring baby boomers. Over 10% of United States housing stock is second homes owned primarily by baby boomers which sit vacant for most of the year. An open question is how many of these second homes will become primary residences, leading their owners to sell their current primary residence and thereby add to inventory.
Household formation provides a constant source of new demand for both newly constructed and resale homes. During the last decade, net new household formation averaged approximately 1.4 million per year. Last year, however, the Census reported that the United States added only 544,000 new households ? during severe contractions, the young stay at home, singles ?double up,? and household formation normally slows. Even with declining demographics, however, many analysts foresee new household growth resuming to a level of at least 1 million by 2010 and beyond.
Of course, the health of the overall economy contributes to the rate of home purchases at the same time the health of home construction contributes to the overall economy. Rapid improvement in housing starts and construction have been a major source of economic recovery and job growth following all of the post war recessions. But establishment economists have repeatedly stated that the pace of recovery out of this recession will be exceptionally slow. The Federal Reserve made that point in its last minutes. Fed Chairman Ben Bernanke and White House economist Larry Summers have both reiterated that position.
A slow recovery that does not follow the pattern of recession recoveries over the past 50 years will slow down household formation as well as job and wage growth needed to support new home purchases. Also, during the past quarter century, falling interest rates on home mortgages have repeatedly enhanced housing affordability. Falling rates have contributed to the demand for new construction. Going forward, further decreases in home mortgage rates are unlikely
Putting this all together, there are a host of unknowns. It seems no more than 50% likely that housing starts will regain a normal 1.5 million unit level in the next three years.